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What to Know About a Trade...Before You Make It

When you look at a futures chart it can seem easy to trade. Gold is moving up, so I will buy some. Or maybe it dropped a lot so you figure it is due for a bounce, and buy some. This is how many people trade, and why most of them lose while doing it. Trades should be planned. Here's what you should know about a trade, before you even take it.

What's the Entry Point or Trade Trigger?
Buying or selling on whim isn't conducive to trading success. Each trade is based on impulse so it's very hard to see what works and what doesn't over many trades. This is why successful traders develop and use strategies. A strategy tells them when conditions are right for trading, and when they should act. A buy or sell order isn't executed because it feels right or they are afraid they will miss a move, a specific set of circumstances must materialize before getting into a trade.

Where Will You Get Out of a Losing Trade?
A trade is taken with the intention of making a profit, but trades will not always do what is expected, and a losing position results. Define exactly how much you are willing to risk. Set a stop loss at that level. This should be at a level that lets you know you are wrong about the market direction, at least for now.

 If Gold just put in a low price, and you buy a bounce expecting it to go higher, your stop loss could go just below the recent low price. If the price reaches that stop loss it gets you out of the trade because, at least for the moment, the price isn't moving higher.

What's the Position Size?
Now that you know your entry point and stop loss level, you know the risk (in ticks or points) for your trade. You can then convert this to a dollar amount based on the futures contract you are trading. To see how much a tick or point is worth, see Contract Specs on the Chicago Mercantile Exchange website.

This dollar amount should ideally be less than 1% of your account. At maximum, risk 2% of your account per trade. If the dollar amount is less than 1% (or 2%, depending on what you choose), you can take more than one contract. How many contracts you take is your position size. Your position size should be perfectly calibrated to the specifics of a particular trade and to your account size. For more details see Calculate the Perfect Futures Position Size.

Where Will you Get Out of a Profitable Trade?
Have a plan for getting out of a profitable trade. This could be a trailing stop loss, a profit target, or getting out when the signals that got you into the trade disappear. Think of different scenarios which could develop and consider how you will handle them. A well defined trading strategy should do this for you.

Final Word
Now that you know your entry point, stop loss level and how you will exit a profitable trade, consider the reward:risk on the trade. Knowing what you know now, is the trade worth taking? Does the upside outweigh the downside? If it does, proceed. If not, look for another opport

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